Chart of the Week: Hog Prices and the Deadly Diarrhea Swine Virus

Sometimes the headlines just write themselves… We might have been writing about hogs today given their sharp move higher and multiple “limit up” days in a row; but when we found out the move was from a deadly diarrhea swine virus… well, that’s just too good to pass up.

One might think the public would have heard about something as unique as this, but Kelsey Gee at the Wall Street Journal details that the virus started almost a year ago, and uncovers the scope of the situation.

“Porcine epidemic diarrhea virus has spread to farms in 25 states and killed millions of young pigs since it was identified in the U.S. for the first time last April, and the number of confirmed new cases each month has accelerated since late last year, according to industry estimates.

Last month, the U.S. Department of Agriculture trimmed its forecast for total U.S. pork production this year by 160 million pounds to 23.4 billion, citing the continued spread of the virus. Its forecast marked a 1% increase over 2013 output, down from a 2% increase projected in January. The government is scheduled to update its forecast on Monday.”

Well, it’s nice to hear this isn’t spreading to humans (a la Mad Cow or Bird Flu), but did he just say millionsof hogs? We happen to have someone in the office whose grandparents used to be pig farmers (among others) and know that it usually takes six months for young hogs to grow up. Theoretically, that means we should have started experiencing a shift in lean hogs in September, but we’re only now seeing a spike due to the lack of supply.

(Disclaimer: Past performance is not necessarily indicative of future results.)
Chart Courtesy: Finviz.com
(If wondering why the chart is all jacked up, see here and here.)

Hogs have been up 15 out of the past 20 days, with a run of six straight up days in there and two “up limit” moves based on this diarrhea virus, catching more than a few traders on the wrong side of the Hog market:

“I’ve been around this market 28 years, and this is the most extreme situation of wild panic that I’ve ever seen,” said Dennis Smith, a commodities broker at Archer Financial Services in Chicago. Traders who had bet on lower prices “were just run over,” he said.”

These ‘limit up’ moves can be worrisome for Managed Futures managers and systematic programs who risk only a small percentage of total equity on any one trade (typically at or below 1.0% of equity), because the market won’t let them out during such moves, meaning their willingness to risk $10,000 on $1 million could mean a loss of $15,000 or $25,000 by the time they are able to get out of the position.

Just what is ‘up limit’ or as it’s also called – ‘Limit Up’? Well, besides being on our Best (futures) investing movies ever list, Limit Up is a unique futures phenomenon where the exchange halts trading if a market moves too far up (or down… Limit Down) and there are no offers at that price. In layman’s terms – when there are no more market participants willing to sell at a price 3% above yesterday’s close, the market shuts down until tomorrow, or until someone comes in and is willing to sell at or below that price. This is similar to the circuit breakers employed on the NYSE, and is intended to give people time to catch their breath, reassess the situation, and allow for better price discovery.

The CME sets the lean hog price limit move at 0.03¢ above or below the previous day’s settlement price, which might not seem like a lot, until you consider it represents about a 3% move. Both Live Cattle and Feeder Cattle have the same 0.03¢ limit.

So what if a CTA was caught in on a short position, would there be a hell to pay? Let’s consider a $1 Million account risking 1% per trade and using the 6 day Avg True Range of $1,398 as a risk amount – they would be doing 7 contracts (1%*$1mm = $10k/$1,398). Now, the two limit moves in Hogs saw prices go up (there may have been some offers in there, we’re assuming there were none for this example) from an opening of 103.85 to 112.575 three days later. At $400 per full point, on 7 contracts, our theoretical CTA would be looking at losses of about $25,000, or 2.5%. And if we assume they were almost out of their position the day the market’s locked limit and this entire extra loss was on top of their desired 1% loss, that’s a 3.5% loss – not the end of the world, but about three times as much as they wanted to lose on the trade.

How common are these limit moves? Not very, although Lean Hogs has already experienced more “up limit” move days in the past two months than in the past three years… and it’s only one limit move away from tying the number of moves in 2008. The question is… will we see more to come if the virus isn’t controlled?

(Disclaimer: Past performance is not necessarily indicative of future results)

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DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. You should not rely on any of the information as a substitute for the exercise of your own skill and judgment in making such a decision on the appropriateness of such investments.

The entries on this blog are intended to further subscribers understanding, education, and - at times - enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts. Opinions expressed are that of the author.

The mention of specific asset class performance (i.e. +3.2%, -4.6%) is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.), and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship and self reporting biases, and instant history.

The performance data for various Commodity Trading Advisor ("CTA") and Commodity Pools are compiled from various sources, including Barclay Hedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The mention of general asset class performance (i.e. managed futures did well, stocks were down, bonds were up) is based on RCM’s direct experience in those asset classes, estimates of performance of dozens of CTAs followed by RCM, and averaging of various indices designed to track said asset classes.

The mention of market based performance (i.e. Corn was up 5% today) reflects all available information as of the time and date of the publication.

The owner of this blog, RCM Alternatives, may receive various forms of compensation from certain investment managers highlighted and/or mentioned within the blog, including but not limited to retaining: a portion of trade commissions, a portion of the fees charged to investors by the investment managers, a portion of the fees for operating a fund for the investment managers via affiliate Attain Portfolio Advisors, or via direct payment for marketing services.

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Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.

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Disclaimer

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.
The mention of market based performance (i.e. Corn was up 5% today) reflects all available information as of the time and date of the publication.